2. Economic Costs
• The payment that must be made to obtain
and retain the services of a resource
• To calculate for economic costs, you must
remember, all of the resources used by the
firm have an opportunity cost.
• Resources include that a firm purchases
from outsiders as well as for the resources
that it already owns.
LO1 7-2
4. Economic Costs
TWO TYPES
1)Explicit Costs
• Monetary payments
• They are opportunity costs, every
monetary payment used involves foregoing
the best alternatives that could have been
purchased with the money.
LO1 7-4
5. Economic Costs
TWO TYPES
2)Implicit Costs
Are the opportunity costs of using the resources that it
already owns to make the Firm’s own product rather
than selling those resources to outsiders for cash.
• Value of next best use
• Self-owned resources
• Includes normal profit -
is a payment that must be made by a firm to obtain
and retain entrepreneurial ability
LO1 7-5
8. Short Run and Long Run
• These two conceptual periods of the firms to
adjust its plant capacity- the size of the factory
building, the amount of machinery and
equipment and other capital resources.
LO1 7-8
9. Short Run and Long Run
Short Run
• Too brief for a firm to alter its plant capacity
• Some variable inputs-apply larger or smaller
amounts of labor or materials and other materials.
• Fixed plant capacity
LO1 7-9
10. Short Run and Long Run
• Long Run –is period long enough for it to adjust
the quantities of all the resources that it employs,
including plant capacity
• All inputs are variable-
• Variable plant
• Firms enter and exit – firm has enough time to
dissolve and leave the industry or for new firms to
create and enter industry.
LO1 7-10
11. Short-Run Production Relationships
• Total Product (TP)
• Marginal Product (MP)
• Average Product (AP)
• In the short run, the firm can increase its output
by adding units of labor to a fixed plant
LO2
Marginal Product
Change in Total Product
Change in Labor Input
=
Average Product Total Product
Units of Labor
=
7-11
12. Total, Marginal,and Average Product: The Law of
Diminishing Return
(1) (2) (3) (4)
Unit of the Variable
Resources Total Product
Marginal Product (MP)
Change in (2),
Average
Product (AP)
(Labor) (TP) Change in (1) (2) ÷ (1)
0 0 0
1 10 10.00
2 25 12.50
3 45 15.00
4 60 15.00
5 70 14.00
6 75 12.50
7 75 10.71
8 70 8.75
10
15
20
15
10
5
0
-5
Increasing
Marginal
returns
Diminishing
Marginal
returns
Negative
Marginal
returns
Marginal product measures the change in total product
associated with each succeeding unit of labor.
When total product is at a maximum,
marginal product is zero.
When total product declines, marginal
Product becomes negative
Marginal product exceeds average product,
average product rises
13. The Law of Diminishing Returns
LO2
TP
MP
AP
Increasing
Marginal
Returns
Diminishing
Marginal
Returns
Negative
Marginal
Returns
1 2 3 4 5 6 7 8 9
0
10
20
30
Total
Product,
TP
1 2 3 4 5 6 7 8 9
20
10
Marginal
Product,
MP
7-13
14. Short-Run Production Costs
• Fixed Costs (TFC)
• Costs do not vary with output
• Variable Costs (TVC)
• Costs vary with output
• Total Costs (TC)
• Sum of TFC and TVC
• TC = TFC + TVC
LO3 7-14
15. Total Cost in Short Run Production
Total-Cost Data
(1) (2) (3) (4)
Total Product
Total Fixed Cost
Total Variable
Cost Total Cost (TC)
(Q) (TFC) (TVC) TFC + TVC
0 100 0 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030
17. Per-Unit, or Average, Costs
• Average Fixed Costs AFC = TFC/Q
• Average Variable Costs AVC = TVC/Q
• Average Total Costs ATC = TC/Q
• Marginal Costs MC = ΔTC/ΔQ
LO3 7-17
18. Per-Unit, or Average, Costs
LO3
Costs
1 2 3 4 5 6 7 8 9 10
0 Q
50
100
150
$200
AFC
ATC
AVC
AVC
AFC
7-18
20. MC and Marginal Product
LO3
Average
Product
and
Marginal
Product
Cost
(Dollars)
MP
AP
MC
AVC
Quantity of Output
Quantity of Labor
Production Curves
Cost Curves
7-20
21. Long-Run Production Costs
• The firm can change all input
amounts, including plant size.
• All costs are variable in the long run.
• Long run ATC
• Different short run ATCs
LO4 7-21
22. The Long-Run Cost Curve
LO4
Long-Run
ATC
Average
Total
Costs
ATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
7-22
23. Economies and Diseconomies of Scale
• Economies of scale – “economies of mass
production
• Labor specialization
• Hiring more workers allows subdivision of tasks
• With fewer tasks make workers more proficient
• Managerial specialization
• Large scale operations creates specialists rather than
generalists
• Efficient capital
• Spreading the high cost of equipment over large production
• Other factors
• Start-up costs, advertising costs
• Constant returns to scale
LO4 7-23
24. Economies and Diseconomies of Scale
• Diseconomies of scale
• Control and coordination problems
• Communication problems
• Worker alienation
• Shirking
• Avoiding work in favor of on-the-job
leisure
LO4 7-24
25. MES and Industry Structure
• Minimum Efficient Scale (MES):
• Lowest level of output where long-
run average costs are minimized
• Can determine the structure of the
industry
LO4 7-25
26. MES and Industry Structure
LO4
Output
Average
Total
Costs
Long-Run
ATC
Economies
Of Scale
Constant Returns
To Scale
Diseconomies
Of Scale
q1 q2
7-26
27. Don’t Cry Over Sunk Costs
• Sunk costs
• Costs have already been incurred
and thus are irrecoverable
• Rule: Do not engage in any activity
where MB<MC
• Rule: Ignore sunk costs
• They are irrecoverable
7-27
